Back in February, many investors were betting that the buildup of Russian troops on the Ukrainian border was nothing more than an elaborate bluff.
Russian and Ukrainian currencies appreciated as hedge funds and private equity firms signaled confidence in some form of an emerging peace deal, confidently bought in rubles and Ukrainian hryvnia.
Today, there is a war that has effectively blocked raw materials and food usually exported by both nations, and no one knows when the conflict will end.
It is clear from the collapse of global stock markets and falling cryptocurrency values that investors are panicked by the uncertainty. In the United States, where the S&P 500 index is down nearly a quarter since January, stocks had their worst start to the year in 60 years.
We’ve seen panics before, especially after the crash of 2008. Investment firms, despite their reputation as smart stewards of pension money, always hit the sell button at the first sign of trouble. Collectively, this leads to a rout.
Seasoned decision makers know how to respond in these uncertain times, which is to do whatever it takes to reassure investors that their money is safe. Western governments tapped into their reserves and, when that liquidity ran out, borrowed heavily to maintain a stable outlook for their economies. Vital support arrived in the form of cheap borrowing from central banks. With low interest rates acting like the cavalry in a John Wayne movie, everyone could be assured that the panic will be short-lived.
Not anymore. This time there is a real war, not only financial, and no one knows what to do. The major powers disagree on how to combat it, and policymakers disagree on how to handle the fallout, especially the shortages of raw materials and food from Ukraine and Russia that push inflation to 10% and beyond.
In particular, central banks have lost their temper. Instead of being a reassuring presence, they add to the feeling of panic by increasing the cost of borrowing. As one analyst said of the U.S. central bank’s decision to raise interest rates by 0.75 percentage points last week: “The Federal Reserve will raise interest rates up to what policy makers break inflation, but the risk is that they also break the economy”.
On Thursday, the Bank of England pushed its key rate to 1.25% after a period of more than a decade in which it had never risen above 0.75%. Some analysts believe the base rate will rise to 3% by the end of next year after Threadneedle Street put fighting inflation above sustaining growth.
We know that an increase in the cost of borrowing in the UK, the Eurozone and the US, which we are seeing right now, will do nothing to lower prices.
Inflation is an affliction caused by Russia’s invasion of Ukraine and, to a lesser but important extent, China’s difficulties with Covid after its vaccine development failures, which caused blockages and repeated blockages in ports. In the UK, Brexit adds another important twist as it has hurt trade and reduced the number of available workers.
The justification for higher interest rates must therefore lie elsewhere, and central banks, to justify their spasm of action, argue that they must move forward to avoid a wage spiral – one where wages exceed inflation.
In Britain, this argument assumes that the average worker, to avoid a decline in personal living standards, will be able to negotiate a wage deal that exceeds the Bank of England’s latest forecast of an 11 % later this year.
While the government is expected to limit public sector wage increases to between 0% and 3% this year, that means private sector increases are expected to be even higher – around 12% or 13% on average. These levels of wage increases are a fiction. Workers’ power, outside of a few discrete pockets of the labor market, is a mirage.
Still, the Bank looks likely to go ahead anyway, which leaves anyone looking for reasons to remain confident looking to Rishi Sunak.
The Chancellor has made it clear that he values fiscal rectitude above the “whatever it takes” open-ended commitments needed to foster confidence. He has warm words for investors on low corporation taxes, special visas for foreign entrepreneurs and a warmed-up Thatcherite plan to increase the number of workers by forcing more people on benefits to look for work.
This is a weak set of micro-policies that will do little to improve the mood of companies looking to invest in the UK. No wonder the pound fell. Few investors want to buy British right now, and who can blame them?